Question 1

Which of the following would most likely be considered a fixed cost for a given time period?

Accepted Answer

The salary of the Chief Financial Officer (CFO) is considered a fixed cost because it does not change with the level of production or sales within a given time period. Unlike variable costs such as sales commissions, shipping expenses, and cost of goods sold, which fluctuate with business activity, the CFO's salary remains constant regardless of the company's operational volume.

Question 2

The NPV computed using static DCF analysis is _________ if the project gives us the opportunity to abandon the project if things go poorly; that is, it includes an option to abandon.

Accepted Answer

The NPV computed using static DCF analysis is understated if the project includes an option to abandon because this analysis does not account for the value of flexibility that the option to abandon provides.

Question 3

The NPV computed using static DCF analysis is _________ if the project gives us the opportunity to invest additional funds if things go well; that is, it includes an option to expand.

Accepted Answer

The NPV computed using static DCF analysis is understated if the project includes an option to expand. This is because static DCF does not account for the additional value that flexibility or options (such as the option to expand) can bring to a project.

Question 4

The sales level that results in a project operating cash flow exactly equal to zero is called:

Accepted Answer

The cash break-even point is the sales level where the operating cash flow is zero, meaning the project generates just enough cash to cover its cash expenses.

Question 5

Sensitivity analysis is the term used to describe the process of examining the effects on the net present value of a project when:

Accepted Answer

Sensitivity analysis involves changing the value of one variable at a time to see how it affects the net present value (NPV) of a project, allowing for the assessment of the impact of each variable individually.

Question 6

To determine the degree to which the projected net present value of a project is dependent upon a single variable you should conduct _____ analysis.

Accepted Answer

Sensitivity analysis is used to determine how different values of an independent variable affect a particular dependent variable under a given set of assumptions. This analysis is particularly useful in assessing the risk associated with a specific variable on the projected net present value of a project.

Question 7

When you apply the highest sales price and the lowest costs in a project analysis, you are constructing:

Accepted Answer

A best case scenario is constructed by applying the highest sales price and the lowest costs, as it represents the most optimistic outcome for the project's financial performance.

Question 8

Which one of the following statements about costs is correct?

Accepted Answer

A decrease in total fixed costs, while keeping all other factors constant, will reduce the overall expenses associated with a project. This reduction in expenses increases the project's profitability, thereby increasing its net present value (NPV). The NPV is a measure of the profitability of an investment and is calculated by subtracting the project's costs from the present value of its expected cash flows. Lower fixed costs mean lower total costs, leading to a higher NPV if all other factors remain unchanged.

Question 9

Forecasting risk emphasizes the point that the soundness of any management decision based on the net present value of a proposed project is highly dependent upon the:

Accepted Answer

Forecasting risk is primarily concerned with the accuracy of the cash flow projections used in the analysis, as these projections directly impact the calculated net present value (NPV) of a project, influencing the decision-making process regarding the project's viability.

Question 10

The point where a project produces a rate of return equal to the required return is known as the:

Accepted Answer

The financial break-even point is where a project generates a return equal to the required return, ensuring that the project's net present value (NPV) is zero and investors receive their expected rate of return.

Question 11

The sales level that results in a project net present value exactly equal to zero is called:

Accepted Answer

The sales level that results in a project's net present value exactly equal to zero is referred to as the financial break-even point. This point indicates where the project generates enough returns to cover its initial investment and associated costs, without generating profit or loss.

Question 12

A farmer near Medicine Hat hires a grain harvesting crew from Saskatchewan to harvest his wheat at the end of each summer. Because the crop yield varies from year to year, the crew charges the farmer according to the number of bushels actually harvested each year. For capital budgeting purposes, the harvesting charges should be classified as

Accepted Answer

The harvesting charges vary with the number of bushels harvested, making them a variable cost, as the cost changes based on the output (crop yield).

Question 13

Margerit is reviewing a project with projected sales of 1,500 units a year, a cash flow of $40 a unit and a three-year project life. The initial cost of the project is $95,000. The relevant discount rate is 15 percent. Margerit has the option to abandon the project after one year at which time she feels she could sell the project for $60,000. At what level of sales should she be willing to abandon the project?

Accepted Answer

To determine the level of sales at which Margerit should be willing to abandon the project, we need to compare the present value (PV) of continuing the project for its full term against the PV of abandoning it after one year. 1. Calculate the annual cash flow: 1,500 units * $40 = $60,000.2. Calculate the PV of continuing the project for three years, not including the initial cost, as the question asks for the sales level at which to abandon, implying a focus on operational cash flows:   - Year 1: $60,000 / (1 + 0.15)^1 = $52,173.91   - Year 2: $60,000 / (1 + 0.15)^2 = $45,369.57   - Year 3: $60,000 / (1 + 0.15)^3 = $39,452.23   - Total PV of continuing = $52,173.91 + $45,369.57 + $39,452.23 = $136,995.713. Calculate the PV of abandoning the project after one year:   - Year 1 cash flow PV: $60,000 / (1 + 0.15)^1 = $52,173.91   - Plus the sale of the project: $60,000 / (1 + 0.15)^1 = $52,173.91   - Total PV of abandoning = $52,173.91 + $52,173.91 = $104,347.82Given that the question asks for the sales level at which Margerit should abandon the project, we adjust the calculation to find the break-even point where the PV of continuing equals the PV of abandoning. However, the provided solution directly answers the question without showing these detailed steps for recalculating based on different sales levels. The correct answer (B) 923 units, suggests a calculation that factors in the reduced cash flow that would make the PV of continuing the project equal to the PV of abandoning it. This specific number likely comes from adjusting the annual cash flow ($40 * sales units) and recalculating the PVs to find the point where continuing and abandoning the project have the same value, considering the option to sell the project for $60,000 after one year. The calculation involves finding the sales level that, when multiplied by $40 and then discounted, equals the PV of abandoning the project. The correct sales level for abandonment, based on the provided options, is 923 units, indicating that at this level of sales or lower, the PV of abandoning the project is more favorable or equal to continuing it.

Question 14

Last month you introduced a new product to the market. Consumer demand has been overwhelming and appears that strong demand will exist over the long-term. Given this situation, management should consider the option to:

Accepted Answer

Given the overwhelming and long-term strong demand for the new product, management should consider expanding to meet this demand and capitalize on the market opportunity.

Question 15

If you want to determine the entire range of project outcomes that are reasonably likely to occur you should use _____ analysis.

Accepted Answer

Scenario analysis is used to determine the entire range of outcomes that are reasonably likely to occur by examining various possible scenarios. This helps in understanding the impact of different conditions on project outcomes.

Question 16

Which of the following would likely be considered a variable cost for a given time period?

Accepted Answer

Sales commissions are typically considered a variable cost because they vary directly with the level of sales. The more sales made, the higher the commissions paid out.

Question 17

Which of the following statements regarding operating leverage is correct?

Accepted Answer

Operating leverage is a measure of how revenue growth translates into growth in operating income. High operating leverage means a company has a higher proportion of fixed costs in relation to its variable costs, thus firms with high operating leverage indeed have higher total fixed costs.

Question 18

If you are contrasting the most optimistic situation to the most pessimistic situation which might be created by a project you are conducting _____ analysis.

Accepted Answer

Scenario analysis is used to evaluate the potential outcomes of a project under various future conditions, including the most optimistic and pessimistic scenarios.

Question 19

Which of the following statements is accurate?

Accepted Answer

The relation between project life and payback period does not provide direct information about the Net Present Value (NPV) of a project. NPV is calculated based on the present value of cash inflows and outflows over the project's life, and a project can have a positive NPV even if its payback period is longer than its life, or vice versa.

Question 20

The sales level that results in a project's net income exactly equal to zero is called:

Accepted Answer

The accounting break-even point is the sales level at which a project's net income is exactly zero. This means that the company has covered all its operating costs and depreciation, but has not made a profit beyond that.

Quiz 11: Project Analysis and Evaluation